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This will be a short column today looking at what is happening to the “liquidity” of Australia’s housing market right now. We measure liquidity many ways, including by reference to actual turnover, the flow of homes coming on to the market each week, the stock of homes that are relisted for sale (think of this as an inventory metric), and auction clearance rates. 
Today I will focus on new listings, re-listings and auction clearance rates. All of this data is kindly supplied by RPData.com. The first chart below shows the rolling monthly new listings of homes across Australia reported on a weekly basis. There are two things we can learn from this information. First, there was an unseasonably strong spike in new listings at the start of 2011, which, as we know, coincided with the east coast floods and the general weakening in market activity. Click to enlarge
 <a href="/images/stories/oct131.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/oct131thumb.gif"></a>
The second thing we can see is that the vendor dynamics changed abruptly in June 2011, wherein new listings fell away strikingly. While this was partly seasonal, it was also probably fuelled by the negative sentiment that was building around house prices at the time combined with the RBA’s jawboning on interest rates. We know, for example, that between February and June 2011 Australians typically expected the RBA to hike interest rates another two to three times, which would have pushed official headline mortgage rates over 8.5% (i.e., highly restrictive territory). 
The final point of note in this chart is that despite the data running through the first week of October, we have yet to identify the traditional spring surge in listings. While there will inevitably be some uplift evinced, it would seem that many vendors don’t need to sell their homes, which makes sense given Australia’s relatively low mortgage default rate (about 0.8% of all borrowers). This has been doubtless reinforced by the lacklustre auction clearance rates. 
The more intriguing question is whether the big shift in consumer sentiment that I have been forecasting for a while now — i.e., from expecting several rate hikes to no hikes or a cut — will feed back into more positive housing market dynamics (I expect it will). 
We have seen from the latest ABS and AFG data some healthy housing finance flows over June, July and August. As previously reported, we have also witnessed a gradual increase in the share of first-time buyers returning to the market. There is no question that affordability has improved: house prices have not risen in over a year while disposable incomes have been expanding at an 8% per annum pace. Finally, we know that the use of fixed-rate loans is increasing sharply given that you can now fix for three years at low rates below 6%. 
The second chart I want to highlight is the stock of unsold homes, or re-listings, over time. I have juxtaposed this against the national auction clearance rate. The lessons are clear: the decline in the clearance rate from over 70% in 2009 to around 50% today has correlated with an inexorable rise in the volume of homes that are available for sale (since more are getting passed in). So while new listings coming to market are low, the overall inventory of properties available for purchase is high. This accords with the soggy price action that we have seen throughout 2011, with combined capital city dwelling values down about 3% to 4% in the year to date. Click to enlarge
 <a href="/images/stories/oct132.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/oct132thumb.gif"></a>
What happens for the remainder of the year really hinges on interest rates. If the RBA cuts or stays on hold with an easing bias, we expect to see a noticeable uplift in housing virility. If in the now increasingly unlikely event — at least according to the financial markets and most economists — the RBA were to consider raising rates again, conditions would obviously remain very limp indeed.
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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chrisjoye-JYhJsTrNRC

Spring market lacklustre, and improvement is in the hands of the RBA

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Today I am going to drill into two key measures of real-time housing market activity: vendor discounting and average time on market. But before I do, I want to take stock of the all-important “rate debate”, which is so crucial to divining our housing destiny. 
Rismark’s bearish view on 2011 house prices (juxtaposed against a bullish position on rents), which we began outlining in September 2010, was predicated most importantly on our belief that rates would rise several times in the year ahead, which, we argued, would lead to “downward pressure on dwelling prices”. 
In November last year we got two hikes (care of the bank “top ups”), and, as I have explained too many times to count, we <a href="https://www.propertyobserver.com.au/economy/we-have-had-more-than-three-rate-cuts-without-the-rba-lifting-a-finger-christopher-joye/2011100351778">arguably received a brace of further “virtual hikes”</a> in 2011 via the impact of RBA “jawboning” on the spectre of rate increases. In particular, all the survey data suggests households have been budgeting on two to three additional hikes, which has helped crush consumer confidence.
As I have noted here before, the financial markets are pricing in a steep reduction in the RBA’s official cash rate over the coming year. These are the same folks who at various times have given us prices that implied rate cuts in 2010 (they rose), rate cuts earlier this year (they stayed on hold), and, at one juncture, a 100% probability of two rate cuts in October (no change). Suffice it to say, the financial markets have been relentlessly wrong. But then, as the RBA and I have gone to some lengths to <a href="https://www.businessspectator.com.au/bs.nsf/Article/reserve-bank-interest-rates-Christopher-Joye-bond--pd20110922-LX7AE?OpenDocument&amp;emcontent_spectators">explain</a>, the interest rate changes implied by financial market prices can be quite misleading. 
Notwithstanding a bounce back in global sentiment in recent days (bet you did not read about the positive US jobs report on Friday night that trounced analyst expectations?), a number of the RBA’s main media proxies have sung a decidedly dovish – i.e., rates heading lower – tune of late. This was presumably prompted by both private prodding and by the fact the RBA has, for the first time in a long time, explicitly countenanced “easing” policy should demand require it. One especially worded-up journo, who implied that he had access to the otherwise highly confidential discussions that take place at the RBA’s board level, claimed that the bank almost cut the cash rate in October but was prevented from doing so by the looming third-quarter inflation data. 
The RBA has invested an enormous amount of capital in its story around the positive income shock wrought by the structural increase in demand for Australian exports from developing Asian countries, which, it believes, will generate long-term inflationary pressures and the need for higher interest rates. It has given scores of speeches and parliamentary testimonies, and published vast volumes of research, in support of this specific thesis. It desperately needs some cover if it is to temporarily abandon it. One partial canopy has been supplied via the modest rise in the domestic unemployment rate to a still-low 5.3%. Yet as a purportedly “inflation-targeting” central bank, the RBA would ideally like the inflation data to also fall in line. 
For what it is worth, I employ the “inflation-targeting” label hesitantly since it is no longer clear whether the RBA has the political fortitude to respond to its forecasts of high inflation – either because it simply has no faith in its own guesses (one distinct possibility) and/or because it is worried about the fallout associated with hiking without the hard inflation case to back up its decision. At this stage, the RBA looks like it will only move rates into genuinely restrictive territory after the event: that is, when it has demonstrable evidence that the inflation cat is out of the bag. 
It seems to think that the risks of getting rate hikes wrong are too great to tolerate, which helps explain why the two core measures of inflation in Australia have averaged 3.2% per annum since 2002 (I only select June 2002 to put some distance between that date and the GST in July 2000). That is, the RBA likely has a policy bias to overshoot its target 2 % to 3% per annum band. 
Many once-hawkish economists have jumped on the burgeoning rate cut bandwagon, which was first kicked off by a now-famous reversal in the views of Westpac’s experienced chief economist, Bill Evans. Evans, who, to his credit, has held dovish dispositions for quite some time now, was reportedly pushed over the edge by a disturbing trip to Europe and North America. Following these meetings, Evans swung from projecting hikes to four cuts, commencing in December. 
After the high second-quarter inflation numbers – which were subsequently revised down – Evans looked like he had spent too much time in the European sun. But with the advent of the US debt ceiling crisis, ever-worsening European sovereign debt problems that threaten the fabric of the entire Euro zone, IMF downgrades to its global growth forecasts, and weakening local employment growth, Evans has quite rightly become the genius de jour. And all power to him: he deserves considerable kudos for making what was, at the time, a rather brave call. 
The only thing we know with certainty is that nobody, including the RBA, really has much of an idea what is actually going to happen on the first Tuesday of November. Some are paid to guess (economists), others are willing to punt (investors), and some like me get to bite their tongues until they obtain better information. 
And it is fair to say monetary policy rests on yet another knife edge, as it has done for much of 2011. If we get another upward movement in the unemployment rate combined with a, say, circa  2% (annualised) or less core inflation outcome, it seems that the RBA is set to abandon its February and August forecasts and undertake a major policy turn. Absent a meltdown overseas, and subject to the impact of bank funding costs on the latter’s “ability” to pass through one-for-one changes in the RBA’s cash rate, the first cut, if it comes, is likely to be 25 basis points. 
In a low third-quarter-inflation scenario, the RBA’s goal, one assumes, will be to put monetary policy back on a more balanced, or “neutral” footing, until it gets more dependable data on the local and global outlook. This implies a modest easing of policy in the form of one to two cash rate cuts. 
As most of the circa 5 million households with mortgages are on fully variable rate loans that can adjust with changes to the RBA’s cash rate, the influence of this decision on Australia’s listless housing market should be immediate. While we have yet to see any discernible improvement in housing atmospherics outside of <city><place>Sydney</place></city>, there are some partial data, such as the housing finance flows, which insinuate that it may be starting to “base”. 
The most important change is already taking place. This relates to the expectations of households regarding the future course of rates. Just as all the talk of rate hikes earlier in the year acted as de facto increases, tamping consumer and housing demand, so the unravelling of this sentiment will almost certainly have the opposite effect. 
The more thorny monetary policy question is what happens if core inflation prints in the third quarter at the top, or, heaven forbid, above the RBA’s 2% 3% target range? In quarterly terms, if the RBA’s two preferred measures of underlying inflation come out at around 0.7% or higher, the central bank will be placed in yet another bind. 
It will no longer have the inflation cover it was seeking: that is, evidence that price pressures are benign, and could be projected to remain around “two point something”. A bad third-quarter release will be all the more surprising given the ABS is adopting a new weighting system that many argue will help eliminate an upward bias, and a more comprehensive seasonal-adjustment method that reduces the risk of seasonally high (or low!) price changes giving us a bum-steer.
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 Similar levels of complexity characterise current housing dynamics. Today I want to touch on two variables that RP Data and Rismark track closely: “vendor discounting”, which measures the amount by which owners have to reduce their list prices in order to secure a sale; and “time on market”, which, as the name implies, simply tells us how long homes remain available for sale before they are sold. The first chart below quantifies the vendor discount over time for Sydney, Melbourne and Brisbane houses. And the story is an interesting one. Whereas owners of dwellings in <place><city>Brisbane</city></place> are having, on average, to drop their list prices by nearly 9% before triggering a sale, the average Sydneysiders’ discount is a considerably lower 6.5%. In comparison to Brisbane, the Melbourne market also looks healthy, with the three-month moving average discount currently sitting at 7.2%. Click to enlarge
 <a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeoct111.gif"><img src="/images/stories/joyeoct111thumb.gif"></a>
As the chart above highlights, discounting is pro-cyclical, and the germane benchmark is obviously the 2008 crisis. Recall that during this episode the RBA had its cash rate slashed by a stunning 300 basis points by December 2008, whereas rates have been held at above-average levels throughout 2011. 
Drilling into the detail further, the Brisbane and Melbourne discounts look like mirror images of their 2008 forebears. In fact, conditions in <city><place>Brisbane</place></city> appear a tad worse, which may be explained by the impact of the floods. While it is similarly difficult to distinguish between the discounting in <city>Melbourne</city> in circa 2008 and 2011, today’s correction should be contextualised against the 29% capital growth realised by <city><place>Melbourne</place></city> homes over 2009-10. 
It is <country-region>Australia</country-region>’s largest city, <city><place>Sydney</place></city>, that seems the stand-out. At the depths of the GFC, Sydneysiders were compelled to cut the value of their homes by 8% to crystallise buy-side interest. Today the discount is 15% to 20% less, and has not increased – or decreased, depending on which way you look at it – nearly as much as its Melbourne or Brisbane equivalents. 
This accords with the story told by RP Data-Rismark’s hedonic indices: while <city><place>Sydney</place></city> homes have actually increased in value over the last 12 months, Melbourne and Brisbane dwelling values are down by 4.3% and 6.1%, respectively.  In the year to date, the Melbourne downdraft has been more noticeable, with values off 6% from their highs. 
The vendor discounting narrative is reinforced by our time on market data (see next chart below). Once again, we find historically very poor conditions prevailing in the <city><place>Brisbane</place></city> market, which look as bad as those that emerged during the GFC. Today the typical home takes about 58 days to sell. The Melbourne market also looks to be enduring a repeat of the 2008 experience, with the average time between listing and sale estimated to be around 50 days. It is <city><place>Sydney</place></city> homes that have again bucked the trend, with the time on market of 49 days well down on the 60 days recorded at the 2008 peak. Click to enlarge
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeoct112.gif"><img src="/images/stories/joyeoct112thumb.gif"></a>
These housing dynamics are important to the RBA. At the limit, it will be cognisant of the risks to bank balance sheets; more specifically, a deterioration in collateral values increasing the probability of a transmission of the North Atlantic contagion. If the stability of the overall financial system is in any way threatened, the RBA will not hesitate to act by reducing rates and ramping up the liquidity it provides deposit-taking institutions via its “repo” facilities. Think 2008 redux. 
This time around, however, Australian banks have far more secure funding lines in place (i.e., with more finance sourced from domestic depositors as opposed to fickle wholesale creditors), and know that the Commonwealth is prepared to use its unblemished AAA credit-rating, if required, to act as a guarantor (or lender) of last resort.
Christopher Joye is a leading financial economist and works with <a href="https://www.rismark.com.au/" title="Rismark International" target="_blank">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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Rates on a knife edge as discounting and time on market increase

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The RBA has waded into the affordability debate. This is one of the reasons I love the Reserve Bank of <place><country-region>Australia</country-region></place>. Actually, truth be known, we have a bit of a “love-hate” relationship. 
On some days I am the bank’s firmest, and only, supporter; a case in point being the in equal parts flawed, jejune and disgraceful media and political criticisms of the compensation of top RBA executives, which I have repeatedly <a target="_blank" href="https://christopherjoye.blogspot.com/2011/09/knee-capping-aussie-central-banks">railed against</a>. 
On others the bank doubtless finds me rather frustrating, such as when I suggest that there is discord among its board, or that the RBA is failing to properly fulfil its financial stability duties by holding Australian banks to account on the unnecessary risks they occasionally expose taxpayers to. 
Today is one of those better moments in our union. Today I am able to objectively shower the bank with praise. Why? Because it has just released a historic <a href="https://www.rba.gov.au/publications/rdp/2011/2011-03">study</a> with far-reaching consequences for our understanding of how <place><country-region>Australia</country-region></place>’s $3.6 trillion housing market works, and, more significantly, what specific policy measures might be implemented to cut the cost of securing well-located shelter. 
On a more technical level, the study’s three authors — Mariano Kulish, Anthony Richards, who is head of the RBA’s economic analysis department, and Christian Gillitzer (hereafter “Richards et al”) — have furnished numerous theoretical, empirical and general policy insights into the impacts of changes in infrastructure investment, zoning ordinances, frictions in the supply of new dwellings, and population growth on house prices, urban densities, land prices, and a city’s size, among other things. 
Described differently, they have presented a range of “counterfactuals” that tell us what our big cities might look like were we to vary existing urban planning and infrastructure policies. 
Unsurprisingly, Richards et al find that the “supply-side” of <place><country-region>Australia</country-region></place>’s housing market matters a great deal when it comes to determining housing costs. While I will discuss their individual results in a subsequent column, today it suffices to highlight their conclusion: 
“While demand-side factors, especially changes in the cost and availability of finance, have clearly been very important in explaining developments in the Australian housing market over the past two decades, our results lend support to other [supply-side] work pointing to the role of structural factors in influencing housing market outcomes. There is a growing body of international evidence on the role of supply-side constraints in limiting construction and driving up prices... The evidence for <place><country-region>Australia</country-region></place> presented in Section 4 is also consistent with various supply-side aspects boosting the cost of housing." 
As a more personally interesting aside, Richards et al quite emphatically affirm (and cite) the arguments and analysis first tendered in my <a href="https://mrcltd.org.au/research/home-ownership/volume_1.pdf">2003 Menzies Research Centre report</a> on the demand- and supply-sides of Australia’s housing market, which was commissioned by the Prime Minister at the time. They also subtly overturn previous RBA orthodoxy on this hotly contested subject, which resisted my 2003 supply-side thesis in favour of demand-side explanations for changes in housing costs over time. 
I would submit that Richard et al’s contributions will emerge as the definitive body of work that future generations of policymakers will rely upon when trying to make the case for greater public infrastructure investment, higher urban densities, speedier approval processes, reduced rigidities on supply-side delivery, and when explaining how we can cost-effectively accommodate a larger population without automatically inflating prices. 
No other government agency could have unilaterally manufactured a study of this kind. No organisation has the human capital to yield unsolicited research of this quality in an area so far removed from its official mandate. No department would dare wade so directly and publicly into such a contentious policy realm without the imprimatur of its political masters. 
For the avoidance of doubt, the RBA is telling us that politicians across the country are culpable for the housing costs that prevail today. There are, furthermore, tractable policy solutions to the affordability problems that exist, but weak-willed officials have mostly avoided them. 
(One gripe I have is that the RBA does not approach the arguably more germane question of banking regulation with the same gusto. Where is the RBA-stimulated debate on the UK Vickers’ prescriptions, for example?) 
A question that naturally springs to mind is: why on earth did Australia’s central bank, which is ostensibly responsible for monetary policy, go to the trouble of publishing such time-consuming research on how to improve housing affordability?* The intellectual genesis of the Richards et al paper is, therefore, worth dwelling on. 
About a decade ago the RBA developed a finer appreciation for the hazardous linkages between asset prices, credit growth and financial instability. 
Itrecognised that rapid asset price appreciation could be both driven by, and insidiously feed back into, credit growth. That is, an economy could be struck by a period of interconnected asset price and credit growth that is divorced from more fundamental factors. 
One might describe this as an “asset price-credit spiral”, which is the financial stability analogue of the “wage-price” spirals that have traditionally given inflation-focused central bankers the willies. 
Crucially, if these cycles cause prices to move materially away from their intrinsic values, they can result in highly distorted consumption and investment decisions (e.g., overinvestment in risky — sub-prime — loans and assets like commercial and residential real estate), the eventual reversal of which — via the “bursting” of the so-called bubble — can have toxic implications for the health of the wider economy. 
Here I am talking about plummeting collateral values in concert with rocketing default rates crystallising catastrophic bank losses, which, at the limit, can precipitate institutional failures in the absence of substantial taxpayer support (such as government guarantees of bank deposits, which, in Australia, account for around 60% of total bank funding, and of wholesale bank debts, which make up the remainder). 
The RBA concluded that it may, as “a policy of least regret”, have to employ its very blunt interest rate instrument (both in terms of the direction and timing of its effects) against the more extreme iterations of these interwoven asset price and credit cycles in order to mitigate their serious risks. 
For the policy wonks out there, the “house view” on this subject is perhaps best encapsulated in <a href="https://www.propertyobserver.com.au/https://www.rba.gov.au/publications/bulletin/2011/jun/8">this recent article</a> by eminent Columbia University Professor Frederic Mishkin, which was released in the RBA’s June Quarter Bulletin. 
With this background in mind, the Richards et al study is really about acknowledging the limitations of what the RBA’s monetary policies are actually capable of achieving. It is implicitly saying that the bank would very much like to avoid the socially and politically challenging exercise of hiking rates in a low inflation environment simply to throw sand in the wheels of asset price bubbles. It is about formally quantifying the very meaningful economic relationships that prevail between federal and state government policies on urban planning, land usage. and infrastructure investment, and the prices that consumers are ultimately compelled to pay in the housing market. It is all but leading the political horses to water in canvassing a menu of constructive policy solutions that could help build more productive, efficient and lower-cost urban environments in the decades to come. 
For this brave work, the RBA deserves its dues. 
*I was, in fact, made aware that this research was coming down the pipeline since RP Data-Rismark supplied much of the data used in it. I had also briefly discussed some of these issues with the authors given my previous work in the field.
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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RBA wades into affordability debate: Christopher Joye

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One of the things that investors and economists struggle with is “dynamics”. George Soros prefers to term it “reflexivity”. In the econo-jargon they have an even fancier sounding term: “endogeneity”.  A brickie might sum it up simply as “the knock-on effect”. 
Bluntly stated, events have consequences, and to have the best possible chance of working out the future, you need to spend a lot of time thinking hard about them. A good example is the current public or “sovereign” debt crisis. All of this started off with a credit crisis among private borrowers. The consensus solution was to bail out the private sector with public money because we wanted to avoid the risks of a 1930s-style depression. 
Setting aside the long-term moral hazard implications of “socialising” private mistakes (i.e., the “heads I win, tails taxpayers lose” dynamic), an unanticipated knock-on effect of the policy reactions to the 2007-09 calamity has been the 2010-11 public debt crisis and, more particularly, the possible disintegration, or at least restructuring, of the Euro zone and its once-successful common currency. 
Another knock-on effect that I’d like to discuss today has been the stunning appreciation of the Aussie dollar during 2010-11. Many economists and investors believed that due to the enormous local investment in resources, Australia would eventually run into an inflation problem, with the consequence being higher interest rates. We did indeed see a rebound in core inflation, and the RBA has dutifully lifted rates to above-average levels. But what most people, including the RBA, did not originally count on was that the Aussie dollar would soar to more than 110 US cents. 
According to the RBA’s research, every 10% increase in the currency reduces core consumer prices by about 1% over the following three years, with most of the impact coming in the first 12 months. We had a peak-to-trough 36% increase in the Australian dollar spot (as measured against the US dollar) since its low of about 81 US cents in 2010. Taking a more reasonable trading range, the rise has been more like 15%. 
The key point is that the unexpectedly strong advance of the currency was a crucial “deflationary” impulse that helped the RBA to keep rates on hold following its first contractionary hike in November 2010. The central bank has recognised this by referring to the role of the currency with mounting regularity as a restraining influence on inflation and activity over 2011. 
Coupled with a rolling series of crises that nobody predicted, from the east coast floods to the Japanese tsunami-cum-nuclear catastrophe to the oil price shocks induced by the Middle Eastern revolutions, domestic hikes that were slated to materialise have gradually disappeared (my own views have not changed). 
Now the economy’s restraining knock-on effects are actually working in reverse. Just when every second bank in the country was upwardly revising its forecast for the Aussie dollar to around 110 US cents or higher, the currency has fallen like a stone on the back of risk aversion arising from the snowballing European woes. 
As I write, it is trading at just 95.28 US cents, and looks like it may break through to 94 US cents. That is a 16% fall from its peak, and a 10% plus decline from its average in 2011 (see chart). Click to enlarge
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeoctober41.gif"><img src="/images/stories/joyeoctober41thumb.gif"></a>
So, while a raft of banks have swung 180 degrees to adjust their interest rate forecasts from hikes to cuts in 2011-12, including, among others, Goldman Sachs, Deutsche Bank, Westpac, Macquarie and AMP, the “shock absorber” that is Australia’s currency is delivering de facto rate cuts as we speak. 
Recall the chorus of calls in the media from countless vested interests that the high Aussie dollar was killing industry? You don’t need to have a plus-size cranium to work out why such whining has suddenly stopped. 
The 10% to 15% fall in the Aussie dollar significantly improves the competitive position of exporters (including those that sit on the RBA’s board) as the price of their goods and services is lower (assuming our trade-weighted exchange rate moves by a similar margin). It also assists import-competing industries, such as manufacturers, given that the price of imports increases (thus making their goods and services relatively cheaper). 
A permanent decline in the exchange rate of this magnitude is also quite explicitly inflationary, as research <a href="https://www.rba.gov.au/publications/bulletin/2011/sep/bu-0911-2a" target="_blank">published by the RBA</a> only a couple of weeks ago shows. 
A final knock-on effect I want to discuss today concerns interest rates. As most know, the RBA is responsible for setting the level of interest rates across the economy via changes to its "official target cash rate". In this context, one of the many good things the RBA does is provide detailed information on the "average" interest rates (e.g., deposit and home loan rates) that prevail across the market. 
I have been writing for quite a while now about how the "inversion of the yield curve" has driven down the cost of fixed-rate loans. This is basically econo-speak for telling you that the financial markets believe that the price of money in the future will be lower than it is today (i.e., future interest rates will be less than current-day rates). The markets believe this because they think the RBA will be forced to cut its cash rate on the back of lower-than-expected global growth. A related nuance, which I have explained in detail before, is that the price of fixed-rate Aussie government bonds has exploded due to the latter’s appeal in a world of deteriorating sovereign credit quality. 
On Monday Australia's largest mortgage broker, AFG, <a href="/news">reported a "huge spike" from 9% to 16% in the share of people using fixed-rate loans</a>. Now, according to the official RBA data, we can say with certainty that the average three-year, fixed-rate home loan has fallen by 0.70 percentage points in recent months, or by nearly three full RBA rate cuts, which would amount to 0.75% (see chart).
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyeoctober42.gif"><img src="/images/stories/joyeoctober42thumb.gif"></a>
Indeed, three-year fixed-rate home loans have not been this cheap since way back in July 2009 (i.e., more than two years ago). The RBA has lifted interest rates on seven occasions since that time. In fact, the cost of three-year fixed-rate home loans actually peaked at 7.8% in April last year. Today's rates are now 1.1 percentage points lower than those levels (the equivalent of more than four RBA rate cuts). 
A similar thing has happened with small business loans (see chart above). According to the RBA's data, the three-year fixed rate for small businesses has fallen from 8.75% in April 2011 to 7.80% today, or by almost a full percentage point (i.e., four RBA cuts). 
In summary, the markets and the economy have responded to quickly deliver the stimulus many doves argue that Australia desperately needs — in the form of a much lower currency and substantially reduced interest rates—without the policymakers at the RBA or Treasury having to lift a finger. This is one illustration of why markets can play a very valuable, self-correcting role. It is also another reason why the RBA will likely keep its finger off the rate trigger until the global dust settles.
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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We have had three rate cuts, without the RBA lifting a finger

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As we move into the summer months, I thought I would share with you my favourite vacation destination: <a href="https://www.kukio.com/">Kukio</a>, and the contiguous <a href="https://www.fourseasons.com/hualalai/">Hualalai Four Seasons Resort</a>, on the Big Island of Hawaii. 
I was actually married in a ceremony on the beach at Kukio, which you can see in the picture immediately below. As my wife and I stood before a Hawaiian celebrant, turtles and whales (and possibly the odd tiger shark) frolicked in the clear blue waters behind us. The portents were certainly promising.
<img src="/images/stories/kukio_0001_kukio1.png.jpg">
Kukio was the brainchild of Michael Meldman, founder of the <a href="https://en.wikipedia.org/wiki/Discovery_Land_Company">Discovery Land Company</a>, who you might have seen star in the TV show Entourage as a bidder for an NFL franchise. 
Another foundation investor in the project was the oil tycoon and philanthropist Billy Getty. I remember my brother-in-law bumping into Billy one day on Kukio’s golf course. He asked him what he did for a job. The billionaire’s response was, “Why son, I won the lottery of life.”
<img src="/images/stories/kukio_0002_kukio2.png.jpg">
Kukio is not actually a hotel, but one of the world’s most exclusive private clubs with circa 350 members. Membership does not come easily: you need to buy a home, which can be priced anywhere from US$3.6 million to $US50 million plus. Two of Kukio’s properties are rumoured to be individually worth more than US$100 million. 
The members themselves comprise numerous billionaires, such as the computer pioneer Michael Dell, and US celebrities. When my wife and I visited Kukio earlier this year we were lazing by the pool (pictured below) alongside Leonardo de Caprio, Cameron Diaz, A-Rod, Naomi Campbell and Toby McGuire. On the same trip we were sipping cocktails at the bar next to Lance Armstrong and Kelly Slater.
<img src="/images/stories/kukio_0000_kukio3.png.jpg">
Kukio is serviced by Kona’s small jet port, which is a 20-minute drive away. Landing over the harsh volcanic rock, which would make mincemeat of any unprepared aircraft, is a surreal experience. The airport itself is quite a sight, with the two tiny thatch huts (think a beach version of Cooma airport) typically enveloped by 50 to 60 private jets. 
At sea-level the Big Island of Hawaii resembles a moonscape with little flora able to survive among the very dry and ashen lava. Yet the island itself is massive (in fact, the so-called Big Island is larger than all the others combined). 
I took the following photo one morning on my BlackBerry. I was standing on the Four Seasons golf course, where it was about 30 degrees centigrade. Yet what you can see in the distance is a lava tube covered by white snow! People actually ski on the island’s highest peaks during the winter months. At sea-level in Kona, however, the weather is most remarkable for its predictable consistency: clear blue skies and 25 to 30 degrees centigrade for 365 days a year.
<img src="/images/stories/kukio4.jpg">
The service and quality of Kukio’s amenities are second to none. For just a few hundred members there are outstanding restaurants, two golf courses, a private beach with dedicated staff to help furnish every conceivable water sport, an enormous gymnasium and spa, three swimming pools, multiple tennis courts, a cinema, playing fields, and so on. 
The Fazio-designed golf course (see below), which has been carved into the volcanic rock above the resort, is a beautiful juxtaposition of the natural and built worlds with “rest centres” every few holes offering marble bathrooms and kitchenettes stocked chock-a-block with delights. The club staff will deliver you lunch on the course, including home-cooked, thin-crust pizzas.
<img src="/images/stories/kukio_0001_kukio5.png.jpg">
One of the great things about Kukio is that it is situated immediately alongside a fabulous <a href="https://www.fourseasons.com/hualalai/">Four Seasons Resort</a>, the freehold underlying which is owned by Michael Dell. So if you don’t know a member, you can stay at the Four Seasons, which is regarded by many as one of the best of its kind. Entry-level rooms are reasonably priced and can be booked for under $1,000 a night. 
If you are interested in buying at Kukio, check out <a href="https://www.propertyobserver.com.au/https://www.kukio.com/component/realestatemanager/view/41/16/71">lot 22</a> below, which is currently on the market for a cool US$15.5 million.
<img src="/images/stories/kukio_0000_kukio.png.jpg">
Christopher Joye is a leading financial economist and works with <a href="https://www.rismark.com.au/" title="Rismark International" target="_blank">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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The best private resort in the world with prices that match the big-name guests

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As we look to what's ahead for 2012, Property Observer is republishing some of our most noteworthy stories of 2011.
 
It never ceases to amaze how distorted investment thinking can get among even seasoned professionals. A classic example is the very different approaches taken to Australian commercial and residential property in the superannuation fund sector. 
Of the nearly $1 trillion in non-self-managed superannuation money (i.e., held by retail, public, government and industry funds), the average portfolio weight to “real estate” is between 10% and 15% of all fund assets. 
Now the rational observer might reasonably assume that there would in turn be a say, 90:10 split in favour of residential over commercial given the relative asset class sizes. The total market capitalisation of private residential property is about $3.6 trillion based on Rismark’s best estimates. In contrast, the total value of all core commercial, industrial, retail and wholesale property is less than $300 billion, according to RMIT. That gives us a rough 90:10 split. 
Another way of building portfolios is via much more sophisticated “mean-variance optimisations”. We have applied this technique over the last 30 years of data and the results are even more damning: you don’t allocate any money at all to commercial property because of its lower total returns, higher volatility, and strong correlation with the business cycle. 
One could also fairly argue that since more than 30% of contributing superannuants have zero exposure to residential property, and those who do have access own one very risky individual asset and presumably possess a powerful motive to get diversification to a truly national portfolio (much like if you only owned Fortescue shares and wanted to diversify across the whole market), super funds have a logical incentive to deliver these imperatives. 
The final nail in the asset-allocation coffin is the risk, return and correlation characteristics of Australian housing. The table below summarises all the major asset-classes’ performance over the last three decades, which is the longest period over which can objectively evaluate the data.
<img src="/images/stories/joyesept281.gif">
On a risk-adjusted basis, a national portfolio of Australian housing has consistently outperformed Australian shares, global shares, Australian bonds, and Listed Property Trusts (LPTs). The “uncorrelated” feature of residential property returns vis-a-vis equities, whereby housing yielded strikingly superior performance during the 1987 stock market crash, when shares fell 44%, the 2001 tech wreck, when global equities collapsed by around 50%, the 2002-03 period, when Australian shares were down 10% to 15%, and 2007-09, the GFC, when Aussie and global equities once again halved in value, implies that housing is a valuable portfolio “diversifier”. 
The most remarkable thing is that notwithstanding the compelling evidence above, your typical Australian super fund has no allocation at all to housing. That is, the 10% to 15% investment in real estate is dedicated almost exclusively to commercial property. There seem to be few sensible reasons for these decisions. 
One controversial explanation that has been proposed to me is that super funds suffer from an insidious form of “industry capture”. In short, most of the executives responsible for managing real estate investments within super funds previously worked in the commercial property sector in one capacity or another. The same is true of the super funds’ advisors: almost all “asset consultants” that focus on real estate come from commercial property backgrounds. 
This possibly gives rise to an instinctive bias to pursue commercial property strategies. At the margin, there are a few funds that do have some residential development holdings. But in an investment sense these are far removed from the traditional, established housing stock. 
There are good reasons why banks happily lend to established housing but avoid developers like the plague: the probabilities of loss are far greater with the latter, as they are with commercial property. Development assets tend to be located on the fringes of cities with lower quality public infrastructure and amenities. The demand for these homes is often less certain while the buyers frequently have lower incomes. This is why the “risk-weighting” APRA forces the banks to apply to commercial property and developer loans is multiples the risk-weighting attached to established residential loans. Through the business cycle, established housing credits have proven to be much safer (as we shall see shortly). 
It is easy to highlight the comparative risks of commercial and residential property. In the first chart below we contrast the performance of the ASX LPT Accumulation Index (reinvesting dividends) with the total net returns generated by Australian housing in the period since 1982. To proxy for housing’s performance, we have used the capital gains plus only half of the gross rents to control for transaction costs. 
 
<hr class="system-pagebreak">
 
Over the past 29 years, a national portfolio of Australian residential property has produced superior total returns (10.6% per annum) with, crucially, nearly one-third the risk. This was borne out most graphically during the GFC. The peak-to-trough fall in the LPT index was a stunning 69% even allowing for dividends. On the other hand, the peak-to-trough fall in boring old bricks and mortar was less than one-10th this amount. Click to enlarge
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyesept282.gif"><img src="/images/stories/joyesept282thumb.gif"></a>
Those in the commercial property industry would argue that the ASX-listed returns tell an artificially negative story apropos their asset-class. They instead prefer to use “unlisted returns” measured by a group called IPD. The problem with these unlisted performance estimates is that they are based on human valuations of capital growth over time. They are not based on actual sales data, or the judgments of thousands of investors participating in an actively traded market.
Many of these unlisted valuations are also commissioned by the fund managers that own the underlying assets, which presents a well-known, albeit rarely acknowledged, conflict of interest. In brief, it has been repeatedly documented that human valuations of commercial properties significantly lag real-world events and materially underestimate true losses. This is why we prefer to rely upon the day-to-day pricing afforded by a market such as the ASX. For the record, the house price data we use here is based on around 40,000 home sales a month, and does not include any human valuations.
On the basis of the analysis presented herein, the really big “bubble” was in commercial real estate, not residential property. 
A similar observation applies to Australian shares. In the next chart I have added the All Ordinaries Accumulation Index to our analysis (grey line), and telescoped in on the past 10 years of data (although note this stops in March 2011, and does not account for the recent share market correction).
Once again, the take-away is that by far the two biggest bubbles were in domestic shares and commercial property. This was illustrated by the tremendous price appreciation generated in the years before the GFC (observe the stunning rise in the blue and grey lines) followed by precipitous 50% plus declines. Australian housing just did what it always does: produced low volatility (viz., risk) total returns that typically track changes in disposable household incomes and borrowing capacity. Click to enlarge
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyesept283.gif"><img src="/images/stories/joyesept283thumb.gif"></a>
 
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In recent years, the RBA has gone to great lengths to highlight the fact that commercial property investments are more hazardous than established housing exposures (see <a href="https://www.businessspectator.com.au/bs.nsf/Article/The-pitfalls-of-commercial-property-pd20100702-6Y9ZX?OpenDocument&amp;src=is&amp;cat=property-al">here</a>). It is widely accepted that bad commercial property loans in 1991 almost bankrupted ANZ and Westpac. 
In this context, the chart below depicts the losses realised by CBA in different parties of its credit portfolio over time. Observe that during the 1991 recession, when unemployment peaked at around 11%, CBA, like the other major banks, suffered an enormous increase in bad debts. These were, however, almost exclusively attributable to CBA’s “business lending” activities, which includes commercial property. Despite a huge increase in unemployment and double-digit mortgage rates, CBA’s losses on its home loans (lower red line) hardly budged. Importantly, a similar pattern reasserted itself during the GFC.
<img src="/images/stories/joyesept284.gif">
The RBA’s bi-annual Financial Stability Review (FSR) is the single most authoritive Australian study on the banking system’s risks. In examining these issues, the RBA offers some fascinating comparisons of the commercial and residential property asset-classes.
The first RBA chart I want to highlight is effectively two diagrams compressed into one. The left-hand-side panel shows commercial property prices in <country-region>Australia</country-region>, the <country-region>US</country-region>, <country-region>UK</country-region>, <country-region>France</country-region>, <country-region>Ireland</country-region> and <country-region><place>Spain</place></country-region> over the period 2003 through to 2011. What is especially interesting is that the RBA’s analysis demonstrates that Australian commercial property prices (blue line) surged way past peer country rates of growth in the years preceding the GFC (note the large protrusion above the other lines). And while Australian commercial property prices naturally fell by a very substantial margin, they remain materially above any comparable country today.
<img src="/images/stories/joyesept285.gif">
In the right-hand-side panel the RBA conducts the same analysis for residential property. Here the results are very different. You can see that in the period 2003 to 2007 Australian house price growth was substantially less than that witnessed in the US, UK, France, Ireland and Spain. In contrast to commercial property, the relative “outperformance” only emerged in the years following the GFC, which makes sense given <country-region><place>Australia</place></country-region>’s underlying economic outcomes. Indeed, even accounting for the deep European recessions, Australian house price growth since 2003 has been substantially less than its French equivalent.
Rismark recently undertook a similar study comparing Australian and <country-region><place>UK</place></country-region> house price growth over a longer period. We used the UK Academetrics house price index because it employs the UK Land Registry’s information, which includes 100% of all <country-region><place>UK</place></country-region> home sales. Other <country-region>UK</country-region> house price measures, such as the <place><city>Halifax</city></place> or Nationwide benchmarks, cover less than 15% of all sales.
Notwithstanding the implosion and ensuing nationalisation of much of the UK banking system, and the exceptionally acute recession experienced in that country, house price growth in Australia and the UK has been nearly identical over the last two decades. In fact, what is most noticeable from this analysis is the much more rapid run-up in <country-region><place>UK</place></country-region> house prices (red line) in the years before the crisis, which significantly exceeded Australian gains. Click to enlarge
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyesept286.gif"><img src="/images/stories/joyesept286thumb.gif"></a>
 
<hr class="system-pagebreak">
 
I want to conclude today’s column with some more charts from the RBA’s Financial Stability Review. The first examines “non-performing” home loans (ie, mortgages in arrears) in <country-region>Australia</country-region>, the <country-region>US</country-region>, <country-region>UK</country-region>, <country-region>Canada</country-region> and <country-region><place>Spain</place></country-region>. What is important to remember when studying this chart is that mortgage rates in <country-region><place>Australia</place></country-region> are much higher than they are in other countries. All things being equal, that would suggest that the probability of default should also be higher in <country-region><place>Australia</place></country-region>. Yet according to the RBA’s latest information, only 0.8% of all Australian home loans are currently three months or more behind.
<img src="/images/stories/joyesept287.gif">
If we assume that there are about 5 million households with mortgages, that implies that only 40,000 are materially behind on their repayments. That is slightly less than the monthly number of sales transacted in <place><country-region>Australia</country-region></place>’s housing market. While the default rate has understandably trended up as the RBA has lifted interest rates to above-average levels, it remains very low by international standards (compare the lower blue line with the <country-region>US</country-region>, <country-region><place>UK</place></country-region>, Spanish and Irish rates). 
The next chart I want to reflect on quantifies the size of “impairments” in <country-region><place>Australia</place></country-region>’s banking system by loan type. As is the RBA’s wont, we are looking at three different charts compressed into one. The first left-hand-side panel shows impairments of residential home loans. Focus on the red line. We can infer here that there are about $2 billion worth of “bad” home loans in <country-region><place>Australia</place></country-region>. In total, there are more than $1.1 trillion home loans outstanding, so only 0.2% are truly impaired.
<img src="/images/stories/joyesept288.gif">
The blue “past due” line above the red impairments looks to be around $8 billion. That makes intuitive sense: if we multiple the 0.8% national mortgage default rate by the $1.1 trillion of loans outstanding we get $8 billion to $9 billion. If we multiply the 40,000 borrowers who are three months behind on their repayments by the average loan balance of $200,000, we also get about $8 billion. 
Now move to the next, middle panel in the chart above. This shows the same analysis for all the banks’ “business” lending activities. Observe how total impairments are around $20 billion. That is, the size of business impairments in <place><country-region>Australia</country-region></place> is about 10 times larger than residential home loan impairments. Recall that this is similar to what happened in the 1991 recession: most bad debts in the banking system originated from the business, not residential, lending portfolios. 
In the next chart, the RBA splits out commercial property loans from total business lending. You can see in the left-hand-side panel that commercial property impairments are much higher than the overall business lending average, which gels with the regulator’s view of commercial property’s more elevated risks.
<img src="/images/stories/joyesept289.gif">
 
<hr class="system-pagebreak">
 
My final two charts illustrate RBA analysis of changes in Australian banks’ lending standards, and <country-region><place>Australia</place></country-region>’s house price-to-income ratio.  In the first we can see that loan-to-value ratios (LVRs) have fallen significantly in the period since the GFC. Indeed, elsewhere in the Financial Stability Review the RBA explains that the recent increase in mortgage arrears has been largely driven by loans that were extended before the crisis hit, not subsequent to it, as is often claimed.
<img src="/images/stories/joyesept2910.gif">
The last chart reinforces Rismark’s analysis of changes in dwelling price-to-income ratios over time. The RBA finds that <country-region><place>Australia</place></country-region>’s “all regions” dwelling price-to-disposable household income ratio is about four times (the actual levels are less useful than the change in the ratio over time). Importantly, this ratio has been falling for a while now; we have had no house price growth in about one and a half years while ABS-reported disposable household incomes have been expanding at a circa 8% per annum pace based on the latest June quarter National Accounts. Like us, the RBA finds that with the exception of a brief dip during the GFC, Australia’s house price-to-income ratio has fallen to its lowest level since about 2003.
<img src="/images/stories/joyesept2011.gif">
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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Commercial, not residential, property in a price bubble

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I had a bizarre experience while sitting in my car the other day. I had pulled over in Bligh Street, in Sydney's CBD, and was finishing up a call. In the space of only three minutes, I saw a multi-billionaire plodding up the road, a hedge fund guy worth a couple of hundred million crossing it, another younger fella who runs a Liberal Party think tank, and who will become a federal minister one day, going the other way, and, finally, the former leader of the NSW opposition, who would be premier today had he avoided certain indiscretions. It was kinda freaky. 



Anyhow, it turns out that one of these blokes called me about an hour later and asked me what the RBA had meant by this curious, and market-moving, statement in its <a href="https://www.propertyobserver.com.au/https://www.rba.gov.au/monetary-policy/rba-board-minutes/2011/06092011">Minutes</a> (emphasis added):



"Members were informed that, in Australia, market pricing prima facie pointed to expectations of large cuts in the cash rate by the end of the year, but a range of technical factors meant that market pricing might not be giving an accurate reading of expectations in the current circumstances."



The deputy governor of the RBA, Ric Battellino, reiterated this view in a speech he gave in New York overnight (emphasis added):



“[F]inancial markets seem to have concluded that the risks are weighted towards the Australian economy weakening sharply and, taken literally, seem to be pricing in a reduction in official interest rates towards the unusually low levels reached after the GFC. There are technical reasons why current market pricing may not be giving an accurate picture of interest rate expectations. Nonetheless, markets do seem to have reached a pessimistic assessment and this appears to be based mainly on the assumption that weakness in the US and Europe will flow through to Australia.”



So what gives? Is the RBA and the considerable weight (and knowledge) of financial markets at loggerheads? Yes and no. While the RBA is an economically conservative institution, you tend to find that alumni have a healthy disrespect for the “efficient markets” doctrine, and the sanity of markets more generally. The Lowy Institute’s Stephen Grenville, who was previously deputy governor of the Bank, exemplifies this attitude in his writings. 



To understand the RBA’s scepticism for markets you need to reflect on its role: the RBA is a non-democratically elected institution that unilaterally sets the price of credit in the economy, and less directly, the price of money. In its own way, the RBA is constantly seeking to “correct” markets and their expectations. Another good example of this is when the RBA (rarely) intervenes in the currency market by buying or selling Australian dollars. It says, quite explicitly, that it only does so when financial markets become disorderly and over- or under-shoot reasonable estimates of fair value. Once again, this is a central bank opining that the markets have got it wrong. Interestingly, the RBA has thus far resisted the temptation to sell Aussie dollars during the recent episode primarily because the appreciation of the currency has only served to validate its medium-term view of the world (and is, to some extent, saving it from having to hike rates).



In responding to my friend’s question about the RBA’s back-hander to the financial markets apropos interest rate expectations, I offered the following explanations.



First, the RBA is very likely subtly pointing out that market pricing for interest rate changes is not a forecast or a prediction, as is commonly believed: it is, more precisely, a “probability-weighted price”. 



Imagine you had three potential contingencies for interest rates over the next year in your mind, and assigned each a probability. The market price would be equivalent to your “expected value”, or your probability-weighted interest rate estimate. 



Now, if I asked you to supply a specific prediction, you would nominate your most likely outcome. Note that this will be different to the expected value. It will be especially different if the expected value is being influenced by a reasonable probability around some catastrophic event, as it is today. 



For example, you might say that you think in your “base case” there is a 70% chance rates will stay on hold until December. But then you add the rider that if, say, the Euro zone were to break up, an event to which you assign a 30% probability, the RBA would be compelled to slash rates by, say, 100 basis points, as it did in October 2008. 



Observe how this gives you a “probability-weighted expectation” of slightly more than one rate cut by the end of the year (if you multiply 70% by the cash rate and 30% by a 100 basis point lower cash rate), which is markedly divergent to your “base case” of no change.



The second thing the RBA is likely canvassing is that the short end of the yield curve, which people use to infer “market forecasts” for rate changes over the next one to two years, is being artificially buoyed by the very high demand for cash (e.g., bank bills) and other near-term, liquid securities. In the currently turbulent environment, many institutions, such as banks and pension funds, are parking their money in cash until the dust settles. This demand for cash has the effect of driving up prices and reducing implied yields. The net result is lower interest rate expectations for the period covered by the securities in question.



The other technical distortion we are seeing is in middle (or “belly”) and long ends of the yield curve, which are dominated by the three-year and 10-year Australian government bond prices. These prices are being artificially boosted for reasons I have explained before: viz., central bank and institutional portfolio diversification of their sovereign investment risks.
 
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As is now well known, Australia is one of the few remaining AAA credits in the world, and has by far the strongest and healthiest balance-sheet of any country in the OECD (including Switzerland). We are pretty much the only developed country that has generated 20 years of uninterrupted growth and avoided recessions during both the 2001 “tech wreck” and the 2007-08 GFC. Furthermore, Australia offers growth diversification away from the North Atlantic economies, which, according to the IMF, account for less than one-third of the global growth pulse. In particular, 65% of Australia’s exports go to developing nations, while 75% go to Asia. The chart from the IMF below shows the expected growth gap between emerging and developed countries over the next two years. Australian investments give you exposure to the top yellow line.
<img src="/images/stories/joyesept22g.gif">
Here is interesting to observe that notwithstanding the extreme media pessimism we are greeted with every day about North America and Europe, the global economy should be chugging along at a trend rate of growth in 2011 and 2012 even assuming very poor conditions in the advanced economies.



Given their high debt-to-GDP ratios, political dysfunctions, ageing populations, and the absence of leverage to emerging economies, many central banks are, at the margin, trying to quite rationally reduce their exposures to the traditional “safe haven” currencies (e.g., the US greenback, yen, sterling, and Swiss franc). And since there are few alternatives in view of the pegged Chinese currency, there has been a tremendous increase in the demand for untainted Aussie sovereign debt with the likes of the Russian central bank announcing that they will start buying it for the first time.



Similar logic applies to global fixed-income investors that hold sovereign credits: in the current climate, safe yet high yielding Australian government bonds are at the top of their shopping list. When buying Aussie bonds, you buy Aussie dollars, so this also explains the currency’s (relative) strength. 



A related wrinkle here is that many offshore buyers of Aussie government bonds are “price indifferent” because the yields are so high and they can hold these assets ‘to maturity’ on their balance-sheets. That is, central banks don't necessarily need to worry as much about “mark-to-market” risks.



The rise in the price of Aussie government bonds as a structural artefact of global investor and central bank portfolio diversification has in turn reduced their implied yields (given the actual interest payments on the bonds are fixed). And so longer-term Australian interest rates also appear to be very low, which would normally insinuate dismal growth prospects. This is exactly what has enabled the major banks to cut the cost of their fixed-rate home loans to more than one percentage point below the headline variable rate.



Within the yield curve, the three- and 10-year government bonds provide the “benchmark” prices. If the three-year price surges, it will tend to bleed out through the rest of the curve. More specifically, the shorter one- and two-year interest rates have very high correlations with three-year rates. In this way, short-term interest rate expectations can be pushed down further as a technical function of the global appetite for Australian sovereign credit.



Taking all of the above factors together, the RBA is basically saying that market expectations are giving you a bum-steer on the likelihood of rate cuts. Sure, we may get them. But absent a total meltdown, they are unlikely to come as quickly or generously as market prices imply.

Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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Absent a total meltdown, sharp rate cuts unlikely

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I heard the other day that the CIA has inducted exposure to Australian equities as an unofficial form of torture. Since January 2009 I have warned of the risk of painful "dead-cat-bounces" in the share market (see, for example, <a href="https://www.businessspectator.com.au/bs.nsf/Article/The-rocky-road-to-retirement-%24pd20090122-NHVS4?OpenDocument&amp;src=srch">here</a>). In May 2010, I argued <a href="https://christopherjoye.blogspot.com/2010/05/comparing-1987-and-2007-stockmarket">here</a> that there was every chance the 2007-08 crash would resemble its 1987 predecessor, and be followed by a protracted period of poor and volatile returns:



"2007 is looking eerily similar to 1987, at least judging by the equities market performance thus far...The bad news for equities investors is that it took until almost 1997 for the market to consistently recover its post-crash peak. Here's to hoping it does not take 10 years for the ASX to breach 6,800 points. (Note the 'dead-cat-bounce' in 1994.)"



In 2011 the Aussie share market is still 37% below its 2007 apogee with countless false dawns heralded by stock spruikers as the beginning of a new year of double-digit returns. It is an instructive exercise to troll back through either Business Spectator or the Australian Financial Review's “annual predictions” of where the share market will be in 12 months hence. It does not look pretty: according to the All Ordinaries Price Index, shares have delivered no net capital returns since 2005 (see chart, click to enlarge).
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyesept201.gif"><img src="/images/stories/joyesept201thumb.gif"></a>
Global shares have not been much better, and super funds, with their unnecessarily high weights to all forms of equities (another problem we have warned about for <a href="https://www.businessspectator.com.au/bs.nsf/Article/The-rocky-road-to-retirement-%24pd20090122-NHVS4?OpenDocument&amp;src=srch">many years</a>), have not protected investors. In fact, according to <a href="https://www.superratings.com.au/latestreturns">Super Ratings</a>, the average “balanced” or “conservative balanced” super fund has underperformed inflation over the last five years – that is, they have delivered negative "real" returns. The numbers look even worse if you allocated to any of the "growth" options offered by your super fund. Before inflation, the average five year return has been 0.5% to 1.3% per annum (after inflation, returns are substantially negative). 
Australian cash and fixed-income have been safe harbours during this turbulent time. Yet as the European sovereign debt crisis continues to rock the world, the risk is that the RBA temporarily "looks past" brewing inflation pressures, as many are calling on them to do, and cuts interest rates. 
In this respect, US investors have the worst of all possible outcomes: high inflation; low growth; low interest rates; and an extraordinarily volatile equities market. Many smart observers are recommending investors seek out "inflation hedges" in our increasingly “stagflationary” world, such as gold, commodities and even bricks and mortar. After years of selling their gold reserves, central banks are back buying again. And only yesterday Bloomberg published an <a href="https://www.bloomberg.com/news/2011-09-18/london-home-prices-surge-as-investors-seek-safety-in-property">article</a> with the headline "London Home Prices Surge as Investors Turn to Property Amid Market Turmoil." 
The inversion of the yield curve that I have been talking about regularly here has started reducing the term deposit rates offered by Australian banks. The concomitant benefit is that the price of fixed-rate home loans has also declined. If the RBA loses its nerve and cuts its official cash rate, I think we will see more capital shifted back into housing given its demonstrated value as a (relatively) safe store of wealth. This is one of the internal inconsistencies the extreme bears face: a recession means home loan rates are going to plunge, which will only help house prices in the unique Australian market where almost all debt is variable-rate. 
While the Aussie share market is still nearly 40% below its 2007 peaks, Australian house prices are about 10.3% above their pre-GFC highs. Notwithstanding this, we have had effectively no house price growth in nearly one and a half years while household disposable incomes have, according to the ABS, raced ahead at an 7% to 8% per annum rate. 
As other wise-heads have observed as we bounce from one crisis to the next, bad news sells and many cannot help themselves when it comes to peddling the end of the world. The online editors at the Sydney Morning Herald are a case in point, and especially fond of promoting doom-and-gloom. 
For example, last month RP Data-Rismark reported that house prices in <country-region>Australia</country-region>'s largest city, <place><city>Sydney</city></place>, had risen despite national values falling. The SMH nevertheless focussed on the national findings and subordinated the <city>Sydney</city> results, running with the headline "Prices fall faster in July" when, in fact, <place><city>Sydney</city></place> prices had actually appreciated slightly. 
If I search out "housing" or "house prices" on the SMH's website, recent headlines include, "Sydney housing in dire trouble", "Housing out of reach for many", "Housing shortage a myth, bears claim", "Domino effect shows as gloom spreads to housing", "House prices to stagnate as debt binges end", and "House prices to slide further in 2012". 
Now contextualise these claims against the hard fact that Australian capital city dwelling prices are merely 2.9% lower than their level of 12 months ago. That is substantially less than some of the more savage daily swings in the share market. Including rents, total gross returns realised by property investors have been positive! 
A more balanced analysis is that while the housing market is certainly soft, it is not collapsing, and, if truth really be known, we are seeing some partial, leading indicators that imply the market may be finding a base. 
The near-term outlook is, as I have been at pains to emphasise for the last 12 to 18 months now, heavily dependent on the course of interest rates, and, it would more recently appear, community perceptions of such. 
The conviction households have held that they would be smashed with at least two to three rate hikes this year has exacerbated the subdued conditions. But the hikes have not materialised, and economists, the financial markets, and journalists are all talking about the prospect of cuts, or at least rates remaining on hold for an extended period. 
Combined with a falling currency (currently down nearly 10% from its recent highs at just 1.018 US cents), which will help exporters and ex-pat demand for local homes, it is plausible that Australia's housing market is rapidly approaching a turning point. 
The final judge of this matter will, of course, be the house price data. But today it is instructive to review some of the aforementioned leading indicators. I would highlight three in particular. 
The first chart below shows the monthly number of AFG housing finance applications, which in August hit its highest level in 19 months. (AFG is <place><country-region>Australia</country-region></place>'s largest mortgage broker and accounts for about 10% of the market.) The three-month moving average is also trending up solidly following the flood-induced trough in January. Click to enlarge
 
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyesept202.gif"><img src="/images/stories/joyesept202thumb.gif"></a>
The second chart of interest illustrates the share of first-time buyers as a proportion of all borrowers. According to AFG, this hit a low of 9.5% in June 2010 and has gradually increased since to 13.8% in August 2011 (the enormous protrusion in the middle of the chart depicts the stimulatory effects of the government's first-time buyer boost). That is to say, there is some early evidence that first-time buyers are returning to the market given the improvement in housing affordability (ie, lower house prices in concert with robust disposable income growth). Click to enlarge
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyesept203.gif"><img src="/images/stories/joyesept203thumb.gif"></a>
The final chart shows weekly auction clearance rates for Sydney, <place w:st="on"><city w:st="on">Melbourne</city></place> and a weighted-average of all capital cities (noting that the auction sales mechanism is more common in the two biggest conurbations). What we can draw from this is that since the second quarter of 2011 clearance rates have stabilised at slightly above 50% in Sydney and Melbourne, and slightly below this level across the combined capital cities. That is, there is no sign of a continued deterioration. Click to enlarge
<a title="Click to enlarge" rel="shadowbox" href="/images/stories/joyesept204.gif"><img src="/images/stories/joyesept204thumb.gif"></a>
The housing market probably needs a little more time to get accustomed to the striking change in interest rate expectations (ie, from several hikes to no hikes, or even cuts, if you believe AMP, Deutsche Bank, Goldman Sachs, Westpac or Macquarie). For what it is worth, I have not altered my own views, and still expect the next move to be up. But set against the cacophony of voices calling for easier monetary policy, my own opinions are likely irrelevant for overall consumer behaviour (having said that, consumers have had similarly hawkish perspectives to this point).



The next major marker will be the August house price index data. This will be a crucial guide to whether Australia's housing market is experiencing an accelerating decline, as folks like the perennial doomsayer <a href="https://www.propertyobserver.com.au/economy/when-harry-met-steve-a-bears-breakfast/2011091551566" target="_blank">Steve Keen would have us believe</a>, or treading water, as I think is much more likely.

Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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House prices merely treading water and unlikely to dive

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<place><country-region>Australia</country-region></place>’s housing market has been given a reprieve, and likely rests at a crucial junction. Perversely, alongside cash investments, housing could prove to be a partial proxy for catastrophe insurance.
A year ago, many of the nation’s top economists were expecting that the RBA’s official cash rate would rise from 4.5%, where it was at the time, to between 5.5% and 6%.
In September 2010, Paul Bloxham was appointed chief economist for HSBC after having spent 11 years working at the RBA. Bloxham immediately junked the forecasts left by his predecessor, John Edwards, who now, ironically, sits on the RBA’s noard, and announced a new forecast of 5.75% for the end 2011 cash rate.
Had Bloxham proven correct, mortgage rates would be heading towards 8.8% today. Yet they remain a full percentage point lower.
According to the RBA, the official standard variable mortgage rate is 7.8%, which is only slightly above its 15-year average. The official discounted variable rate is just 7.05%. And in the past month or two, the cost of fixed-rate home loans has crashed, with deals as low as 6.35% now available from the likes of Members Equity Bank.
As it turned out, we have only suffered one official rate hike, in November last year, notwithstanding that the big banks saw fit to add another 0.2 percentage points to the RBA’s increase to deliver a de facto double hike.
A related dynamic asserting itself in <place><country-region>Australia</country-region></place>’s housing market has been the “hawkish” Australian consumer. Borrowers have been acting as if they were certain to get slammed by another two to three rate increases, according to Westpac-Melbourne Institute survey data.
As late as August this year, about 29% of all people were still banking on four or more hikes. The net effect of all these “phantom hikes” was to place a heavy clamp on housing demand.
As UBS’s Matt Johnson put it, the cost of capital in the housing market was starting to look like it would exceed the projected returns.
There have been at least four important developments that have pushed Australia’s interest rate cycle off course, and which may mean that the housing market is about to turn a corner. The first I want to talk about arrived yesterday.
The Australian Bureau of Statistics released revisions to its recent inflation numbers that have quite materially altered the previously understood inflation dynamics.
This was an unusual innovation: the ABS ordinarily never revises its CPI estimates, for good reason (wages are determined on the basis of these findings).
However, the ABS will, as at the date of the next inflation release, adopt a new methodology to “seasonally adjust” its inflation numbers. So yesterday it showed us the impact of the new method on past releases.
In summary, the long-term “core” or “underlying” measures of inflation were revised slightly higher. More latterly, the final 2010 quarter estimate was upgraded. The first quarter of this year was unchanged at 0.85%. But, crucially, the surprisingly high second quarter core inflation result for 2011 was materially downgraded from 0.9% to 0.6% (the year-on-year core inflation outcomes were similar).
At face value, this quite significantly changes one’s conclusions about the current inflation trajectory. Before we get too excited about the prospect of a benign inflation environment, we will need to wait until next week when the ABS unveils yet another round of revisions. Some commentators have speculated that these may generate further downgrades.
The bottom line is that core inflation in the first half of 2011 is now believed to have been running at a (still high) 2.9% pace rather than the ABS’s much stronger 3.4% plus rate.
This is good news for the housing market. If these numbers are not perturbed by additional ABS adjustments, it means that the RBA has more time to sit pat and watch how things unfold. If the third-quarter inflation numbers that are published in late October print low, some of the major obstacles to the RBA reducing rates will have been removed.
As I showed in Tuesday’s column, the financial markets are now predicting that we will have five to six rate cuts by July next year. Many credible institutions, like AMP, Goldman Sachs, Deutsche, Macquarie and Westpac, all think the next move in rates will be down. This is starting to feed back into consumer confidence, which is the second major factor I want to canvass here.
Yesterday the market was surprised by a very robust rebound in the consumer confidence data back towards its historical average. There is little doubt in my mind that this is being motivated by a big shift in community attitudes around interest rates. Many people are starting to accept that rates will likely remain on hold for the foreseeable future. A much larger share now think rates will actually fall. And fewer are budgeting on the very high four-plus hikes documented previously.
The third development has been the rise in the unemployment rate from its low of about 4.9% to the current 5.3% level. While there are sound reasons to believe that the labour market is not as weak as this spike implies, it still has significant consequences for monetary policy. According to the RBA, the unemployment rate is one of its most valuable guides to future inflation.
The RBA had been looking for unemployment to slowly slide towards 4.5%. Alongside the inflation revisions, the recent slackening in <place><country-region>Australia</country-region></place>’s labour market affords much ammunition for those arguing that rates should be cut, or at least held at current levels.
The final dynamic worthy of mention is the offshore turbulence. Many smart observers think there is a real risk that Greece will, one way or another, exit the Euro zone and drop the common currency in favour of a new one. The argument goes that it is very likely Greece will default on its debts, which will mean net present value losses for the holders of those bonds—mainly European banks and the European Central Bank—of between 60 and 80%.
Rather than subject itself to the burden of external austerity conditions, Greece may choose to swap the Euro currency for a “New Drachma”.
The idea would be to then allow the New Drachma to depreciate significantly, and thereby make Greek goods much less expensive relative to their current prices. The problem with this strategy is, according to Euro experts, that it would almost certainly lead to the complete collapse of the Greek banking system, which would no longer have access to foreign or ECB funding. It would also perpetuate big losses across the European banking sector (hence the recent ratings downgrades by Moody’s), which could in turn compel these banks to ration credit to other borrowers. Over and above the extreme financial market volatility that a Greek exit from the Euro zone would invariably trigger, it would likely place more downward pressure on the already weak economic growth that prevails today.
More worryingly, experts believe that if <country-region>Greece</country-region> goes, this will boost the probability that the likes of <country-region>Portugal</country-region>, <country-region>Ireland</country-region>, <country-region>Spain</country-region> and even <country-region>Italy</country-region> or <place><country-region>Germany</country-region></place> follow. That is, the entire Euro zone could implode. UBS figures that this would lead to massive reductions in economic output across all nations and thus a deep regional recession, if not depression.
So while all of the above might still reside in the “lower probability” camp, it is more than sufficient to give the RBA pause, if not add to the evidence pointing to the need to relax policy.
The key insight here is that this could be perversely beneficial to Australia’s housing market, in which around 90% of borrowers have fully variable-rate debt.
As I have observed before, the RBA has been explicit in stating that it would crimp activity in the consumer and housing sectors in order to “make room” for Australia’s resources boom.
Based on the GDP data published by the ABS over the last nine months, it transpires that consumer spending, and private demand generally, have been healthier than perhaps even the RBA anticipated.
Ordinarily this would connote higher rates. But the economic forces sketched above have conspired against this outcome.
I have repeatedly argued that the highly interest-rate-sensitive household sector would be a good hedge against a collapse in Australia’s resources narrative. If the latter were to happen, the RBA would slash rates, which, alongside a much lower Australian dollar, would strongly stimulate consumption and housing demand. The policymakers’ plan would be for these two areas to, in effect, step into the breach left by a derailed resources sector.
In this respect, it is plausible that <place><country-region>Australia</country-region></place>’s currently soft housing market will emerge as a relative winner from any global fall-out, much as it did in 2007-08.
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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Housing prices at a signal junction: Christopher Joye

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In the standard literature, the so-called “equity risk premium puzzle” refers to the substantial outperformance of listed shares over safer government bonds. The magnitude of the differential in returns generated by these assets suggested to some that investors were inconceivably cautious, or risk-averse, and thus demanded exceptionally high returns from equities in order to compensate them for the market’s sizeable volatility, or risk of loss. 
There are at least three other explanations that I am more sympathetic to. The first is that there is, in fact, only a small – indeed, far too small – equity risk premium over government bonds when you run the right numbers. I will return to that later. 
The second (related) argument is that investors’ portfolios have actually been plagued by quite irrational and poorly compensated “risk-seeking” asset allocations, which have underestimated the probability of loss in, and relative valuations of, shares compared with far more secure fixed-income assets like cash and government bonds. 
I suspect that this irrationality was itself influenced by investor ignorance about corporate capital structure risk and, more fundamentally, the important differences between debt and equity. I have little doubt that these misconceptions continue to prevail at the retail punter level. I would venture they also exist amongst more sophisticated institutional investors. 
One concern is that this equities’ “obsessive-compulsive disorder”, as I like to call it, appears to be a peculiarly Australian affair, which is most endemic in our superannuation system. It is an interesting sociological question as to whether this is somehow linked to our unusually pervasive gambling culture. 
According to the OECD, Australian super funds have far and away the highest exposures to listed equities of the 31 countries they survey (see first chart below). This has manifest in inferior performance vis-à-vis other pension systems around the world. Click to enlarge
 
<a href="/images/stories/joyesept131.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/joyesept131thumb.gif"></a>
Here the OECD finds that over the last three years,“the worst [pension] performance was observed in Spain (-2.0% nominal, -3.8% real), Australia (-2.8% nominal, -5.6% real), Portugal (-3.1% nominal, -4.1% real), and Estonia (-3.7% nominal, -7.7% real). The average, yearly net return over the period [for all 31 countries] was 5.4% in nominal terms and -0% in real terms [ie, dramatically higher than Australia’s results] 
As I have explained before, debt ranks ahead of equity, commits to repay you the dollar value of your original investment, and promises a predetermined rate of return. 
Equity does not offer you a guarantee to return your capital, is subordinate to debt in the event of insolvency (i.e., you get paid last), and directly exposes you to the risk of loss in concert with the prospect of non-specified gains. 
One of the great ironies of the asset-allocation puzzle that has led to excessively high weights to shares in Australian portfolios is, as I explained <a href="https://www.businessspectator.com.au/bs.nsf/Article/fixed-interest-corporate-bonds-equity-returns-pd20110530-HC8N2?OpenDocument&amp;src=srch">here</a>, that debt is, by its construction, far easier for punters to understand, analyse and value than equity. 
The lay observer would not, however, think this given the vast industry complex that has been built up around promoting the share market –with countless online retail stockbrokers and media backers – that in turn make investing in shares seem like it need no more qualification than a functional index finger. 
But as any professional analyst understands, the highly uncertain assumptions and complex discounted earnings models required to estimate the equity returns that may or may not materialise from a listed company are orders of magnitude more sophisticated than valuing a floating-rate debt security.
 
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 It is even more bizarre that the regulator, ASIC, makes it harder for mums and dads to invest in debt than equity, given the greater certainty, security and transparency of the former over the latter (the minimum direct investment is $500,000).
Any chump can create an online trading account to gamble, on say, unsecured <city>Bendigo</city> &amp; Adelaide Bank shares, but heaven forbid if you want to invest in <city><place>Bendigo</place></city> &amp; Adelaide Bank’s senior or subordinated debt securities. 
Chalk that one up as a win to the banking cartel that does not want to be disintermediated from the supply of business credit by an ascendant retail debt capital market, and the hordes of share market salesmen relentlessly spruiking the “value” and purportedly high returns associated with this company or the next. For what it is worth, Aussie government bonds have outperformed global equities over the last 30-plus years. That is to say, there has been a negative equity risk premium between global shares and Aussie government debt. 
Another way of thinking about this is by considering the risk in your own home. When you buy a home, you provide the cash deposit, which is your equity. The bank supplies a home loan, which ranks ahead of your deposit in the capital structure. If things go belly up, the bank’s debt ranks ahead of your equity. The bank gets to sell the home, recover its principal and any unpaid interest, and only then to you get the left overs, assuming there are any. 
Now consider a listed company. Would you prefer to be the bank, or the secured lender to that company, by investing in its debt, or be the mug who provides it with the risky equity capital, equivalent to the deposit for your home? 
A second, related explanation of the equity risk premium puzzle is that the difference in total returns delivered by shares and government bonds is not as great as some claim. For example, Challenger Financial’s actuaries have run analysis that shows once you control for measurement mistakes in the academic literature, such as forgetting that government bonds have a ‘total return’ including both capital gains and income, the performance gap between Australian shares and Australian government bonds has only been about 2% per annum (our numbers are similar). On a risk-adjusted basis – i.e., controlling for the probability of loss – shares look like a comparatively poor investment. In the technical jargon, the so-called “Sharpe Ratio”, or risk-adjusted return, attributable to shares is about half that yielded by Aussie government bonds.
This actually inverts the entire equity risk premium puzzle on its head: could it be possible that, in <country-region><place>Australia</place></country-region> at least, the question is why listed shares have not offered more (rather than less) compensation for their very high risks? Now I have never heard or read that question before. An ensuing query, therefore, is whether in Australia the equity risk premium puzzle is about understanding if investors have had too much – as opposed to too little – risk tolerance. This arguably fits more comfortably with the academic research literature on investors’ behavioural biases.
 One issue that the Challenger analysis has yet to address is the subject of “survivorship bias”, which, if it exists, would further reduce the disconnect between bonds and shares. 
There are at least two forms of survivorship bias. The first is the likelihood that before 30 to 40 years ago, Australian share market indices only included “winners” – or the companies that survived – and do not retain data on the performance of “losers” – i.e., those that have delisted due to corporate distress. 
A second more insidious bias that remains to this day is that when a company goes into insolvency, trading in its shares is suspended, and the last price recorded by the ASX is the pre-insolvency value. Oftentimes the company’s shares will never trade again. Yet as the so-called “residual claimants”, shareholders get paid out last after all other creditors, and their realised returns are, as a result, frequently a fraction of the value implied by the last traded price. 
Following the circa 50% losses experienced in the global share market collapses in 1987, 2001, and 2007-08, and the more recent turbulence wrought by the North Atlantic sovereign debt crisis, Australian retail and wholesale investors are beginning to make some belated changes to their asset-allocations that will see them reduce their equities exposures in favour of higher cash and fixed-income weights. While this could take years to fully implement, it may further depress equity valuations until such a point as the expected future returns implicit in prices offer adequate compensation for shares’ extraordinarily high risk. 
There is also a case that this dynamic will be amplified even more as the population ages and risk-aversion increases: that is, demographic change will drive greater appetite for cash and fixed-income securities.
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The funny thing is, the more the North Atlantic financial markets crap themselves, and the more pressure that is brought to bear by investors, economists, commentators, politicians and ‘policymakers’ on the RBA to cut – or, in extremis, hold – interest rates, the more bullish I feel on both housing and shares! 
As of this morning, the interest rate futures markets are pricing in 5.7 cuts – of one quarter of a percentage point each – to the RBA’s official 4.75% target cash rate by July  next year. That would bring the cash rate down to one hike above its GFC nadir of 3%, and slash mortgage rates back to near-40-year lows (see chart). Click to enlarge
 
<a href="/images/stories/joyesept132.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/joyesept132thumb.gif"></a>
Now I don’t really pay much attention to the financial markets’ precise predictions, because they are so consistently wrong. They are, however, informative in a directional sense. And what makes them more credible is that many smart and thoughtful economists (and investors) are jumping on the doom-and-gloom bandwagon with some notable exceptions, including yours truly. (I am probably the only person in <country-region><place>Australia</place></country-region> who thinks the RBA will still nudge rates higher this year.) 
AMP, Deutsche Bank, Goldman Sachs and Westpac all believe that the RBA will cut rates by between one and two times before we move into 2012. Macquarie Bank forecasts there will be four rate cuts by the end of next year. 
Concurrently, there is mounting pressure being placed on the RBA’s staff by its own board, members of which are reported to have been calling for rate cuts for months, and by untold vested interests – union officials, retailers, exporters, politicians, and share market investors – to, in effect, look past, the RBA’s official 2% to 3% per annum inflation target in the name of “shoring up” employment and growth. As the accountant Anthony Bell argued, why shouldn’t we be allowed to run a Chinese-style inflation rate? 
Since November last year, the RBA has acquiesced, ignoring consecutive way-above-target “core” inflation results in the first half of 2011 that would ordinarily have led to reflexive hikes. Yet the RBA has not simply overlooked the official ABS inflation numbers, and the two measures of “underlying” inflation that the RBA itself designed (which remove the effects of the floods and so forth). 
The RBA has also disregarded its own official forecasts for underlying inflation over the next three years. In the two editions of its Statement on Monetary Policy published this year, the RBA has projected that core inflation would remain materially above the mid-point of its target 2% to 3% per annum range out to 2013. Indeed, it is predicting that inflation pressures will rise over time while also acknowledging that its historical forecasts have had a worrying tendency (the RBA’s characterisation, not mine) to under-club the ultimate strength of <country-region><place>Australia</place></country-region>’s inflationary pulse. 
In his most recent parliamentary testimony, Stevens argued that: “There are periods of tremendous turbulence when I think it is a very good thing for policy to just sit still…You can only do that if you feel that you are in some sense ahead of the game on inflation, which I have felt.” (emphasis added) 
Now noting my points above, and that Stevens and his colleagues went on to describe the underlying inflation pressures reported in the first half of 2011 as “troubling”, “broad-based”, “surprising”, and not directly due to the resources boom, it is an arduous task to understand how the governor can possibly claim that the RBA currently feels “ahead of the game” on inflation. 
This statement seems to fall into the same camp as his claim several testimonies ago that, “[I]n my experience the Reserve Bank never has leaked and, if I can help it, it never will.” As the commentator Alan Kohler wrote at the time, “Yeah, right, and Tiger Woods is gay.” 
 
Historian Stephen Bell of the University of Queensland has documented the problem of RBA leaks using the example of former RBA board member Hugh Morgan: 
“In mid 1997 the Bank's apparent confidence in an 'ethical fix' was questioned when it was revealed that Western Mining Corporation had quadrupled its forward sales of gold [to hedge the risk of price falls] at the same time as the RBA was secretly selling two-thirds of its gold reserves. Hugh Morgan, the CEO of Western Mining, was a member of the Bank's Board at the time. He did not, and was not required to, absent himself from the Board meetings, which dealt with the gold sales.” 
A related irony here is that the RBA and its governor have for years been criticising investors for spending too much time focusing on the North Atlantic economies, and paying insufficient attention to the developing world. This is because a remarkable 65% of all Australian goods exports now go to emerging (as opposed to developed) countries, with 75% sent to Asia alone. 
It is also because over 70% of global GDP growth during the last decade has been created by countries outside of North America and <place>Europe</place>. Even if we ignore growth and simply examine shares of global output measured in US dollars, we find that over half of the world’s output does not derive from the G7 economies. 
 
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In short, the world is a much bigger and more diversified place than the financial markets seem to believe. The risk is that the RBA itself has fallen for the same trap by setting Australian monetary policy on the basis of US and European capital market turbulence. It explicitly acknowledged as much when it reported in the last minutes that the board would likely have raised rates in August were it not for the US debt ceiling crisis. 
While it is not my own central case, if the financial markets and the more bearish economists are right, and the RBA has come to the end of this tightening cycle, Australia’s most interest rate sensitive sector – housing – is likely to be a good place to be. 
We have had no house price growth across <country-region><place>Australia</place></country-region>’s combined capital cities for 19 months now. At the same time, household disposable incomes, as measured by the ABS’s quarterly National Accounts, have grown rapidly at a circa 7% to 8% per annum pace (see chart). Click to enlarge
<a href="/images/stories/joyesept133.gif" rel="shadowbox" title="Click to enlarge"><img src="/images/stories/joyesept133thumb.gif"></a>
If the bears prove correct, and mortgage rates come down 140 or so basis points to around 5.6%, we are likely to see the return of quite healthy house price growth as savers are punished – via lower cash returns – while geared investors flock to the perceived security of bricks and mortar.
Christopher Joye is a leading financial economist and works with <a target="_blank" title="Rismark International" href="https://www.rismark.com.au/">Rismark International</a>. Rismark and RP Data provide house price analytics products, and solutions that enable investors to go long and/or short the housing market. The above article is not investment advice.
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The worse the world gets, the better housing will: Christopher Joye

Roseville is poised for a wave of new apartment development following the NSW Government's rezoning of land around Roseville Station under its Transport Oriented Development program.

The new planning controls have unlocked significant development potential within walking distance of the station, with a number of sites expected to be amalgamated and redeveloped in the coming years as developers seek to take advantage of the increased density allowances.

One of the more restrained developments in the precinct, and set among the first to be delivered having commenced well before the recent changes, is Hyecorp's Juliet. The boutique apartment project is already well under construction and remains on track to welcome residents by the end of the year, offering a markedly different proposition to many of the larger-scale developments now likely to emerge across the suburb.

[smartcode_project:default project_id=7395 project_image_fid=278194]

<a href="https://www.apartments.com.au/new-apartments/juliet-roseville-64-pacific-highway-roseville-nsw-2069">Juliet</a> will comprise just&nbsp;34 one-, two-, and three-bedroom apartments opposite Roseville Station. For Hyecorp, which has delivered projects across Sydney's Lower North Shore for more than three decades, Roseville presented a rare opportunity to address a growing gap in the market.

"<a href="https://www.apartments.com.au/developments/roseville-nsw-2069">Roseville</a> has long been one of the North Shore's most tightly held and desirable suburbs, offering a unique combination of village charm, established greenery, excellent transport connections, and proximity to some of Sydney's best schools and lifestyle amenities," Hyecorp said.

"We recognised a growing demand from local homeowners seeking to downsize without leaving the community they have built their lives around. The location presented a rare opportunity to create homes that cater specifically to that buyer profile."

[smartcode_project:default project_id=7395 project_image_fid=278196]

The six-level development has been designed by <a href="https://www.apartments.com.au/architects/pbd-architects">PBD Architects</a> as a collection of residences that feel more like homes than apartments. The brief centred generous floorplans, abundant natural light, quality finishes, and strong connections to outdoor space.

PBD Architects drew inspiration from Roseville's established garden suburb character, creating a building that sits comfortably within its surroundings rather than dominating them. The architecture incorporates natural materials, soft forms, layered landscaping, expansive balconies, and generous setbacks to strengthen the connection between residents and the suburb's leafy environment.

"The focus was on designing spacious, house-like residences for discerning owner-occupiers and downsizers who wanted to remain on the North Shore without compromising on comfort, privacy, or design," PBD said.&nbsp;

"Every apartment was to feel considered, timeless, and highly functional."

[smartcode_project:default project_id=7395 project_image_fid=278195]

Inside, residences feature engineered timber flooring, stone kitchen benchtops and splashbacks, integrated Fisher &amp; Paykel appliances, ducted air conditioning, and large outdoor entertaining areas designed to take advantage of district and treetop views.

Residents will also have access to a rooftop barbecue and lounge area, alongside practical amenities including parcel lockers, EV charging capability, bicycle storage, a dog wash bay, and a basement car wash facility.

The majority of purchasers so far have been local owner-occupiers from Roseville, Lindfield, Chatswood, Killara, and the broader Upper North Shore, many of whom are transitioning from larger family homes.

"Buyers are looking for spacious, house-like apartments that allow them to downsize without feeling like they are sacrificing comfort or functionality," Hyecorp noted.

"They value large kitchens, generous living areas, ample storage, quality finishes, secure parking, lift access, and low-maintenance living."

[smartcode_project:default project_id=7395 project_image_fid=278204]

Juliet sits directly opposite Roseville Train Station and within walking distance of Roseville Village, while Chatswood's retail and dining precinct is only minutes away. The development is also surrounded by some of Sydney's most established schools, including Roseville College, Ravenswood, Pymble Ladies' College, and Knox Grammar, as well as nearby parklands and golf courses.

Juliet is currently more than 75 per cent sold ahead of its anticipated completion in late 2026.

[smartcode_project_cta:default project_id=7395]

Joel Robinson

Juliet to sit quietly amid Roseville apartment boom

Sherpa Property Group has unveiled the third instalment of its Flourish series, securing full approval for the two-tower, $500 million Flourish Soleira development in Palm Beach.

<a href="https://www.apartments.com.au/new-apartments/flourish-soleira-1150-1154-gold-coast-highway-palm-beach-qld-4221">Flourish Soleira</a> will rise from a prominent site in the commercial heart of Palm Beach, the long-time home of Cash Converters and a range of local retailers.

The project will introduce a new retail and dining precinct at ground level, beneath 286 apartments.

[smartcode_project:default project_id=150017 project_image_fid=370959]

“We’re very committed to not only providing affordable residential offerings that are much needed in Palm Beach, but also delivering a vibrant new commercial heart that complements the extraordinary growth of the southern Gold Coast,” Sherpa Property Group founder Christie Leet said.

The development will sit under Sherpa's Flourish brand, which is aimed at providing a pathway into the beachside suburb for locals, first-home buyers and downsizers. In a move designed to assist first-home buyers entering the market, Sherpa has reserved all one and two-bedroom, one-bathroom apartments exclusively for eligible first-home buyers.

[smartcode_project:default project_id=150017 project_image_fid=370964]

“Our vision through Flourish is to create a vibrant retail and lifestyle focal point within the Palm Beach centre zone, delivering thriving communities underpinned by lifestyle-rich locations,” Leet said.

“So far, Flourish has been an incredible success, and we hope to carry this momentum as we progress the next two Flourish projects in Palm Beach.”

[smartcode_project:default project_id=150017 project_image_fid=371430]

Located across 1150-1164 Gold Coast Highway and 3 Sixth Avenue, the development will comprise two towers. The northern tower will deliver 154 apartments, while the southern tower will add a further 132 residences, helping address ongoing demand for new apartments in the tightly held coastal suburb.

Flourish Soleira will also feature the most extensive rooftop amenity offering ever delivered in Palm Beach.

The two towers will be connected by a skybridge, with residents gaining access to a rooftop recreation deck featuring a full-width swimming pool, hot and cold plunge pools, wellness spaces, a gymnasium, private dining facilities, massage treatment rooms, barbecue areas, a basketball court, golf simulator, indoor and outdoor dining spaces, sun lounges and extensive landscaping.

LPS Group is expected to start construction later this year.

Sherpa is already well advanced on construction of its debut Flourish project, Flourish Amargo, located just around the corner from Soleira. Meanwhile, Flourish Oasis, positioned opposite Amargo, recently commenced construction and has nearly sold out its collection of 47 apartments.

[smartcode_project_cta:default project_id=150017]

Sherpa unveils $500m mixed-use Palm Beach precinct, Flourish Soleira

Are mortgage holders set to get a reprieve from the RBA in 2026?

Big Four bank NAB believes so. They are now expecting the next move from the RBA to be a cut, rather than a hike, which they had pencilled in for August. They are unsure of the timing of the cut however, they note in their latest&nbsp;NAB Economics RBA Watch.

NAB Chief Economist, Dr Sally Auld, said recent data suggests the economy has lost momentum and the outlook for rates has shifted, noting that the broader economic backdrop has changed since earlier in the year.

“The next move in the cash rate is likely to be down, but the timing is uncertain," Dr Auld said.

"In February, growth was above trend, the economy was operating above capacity and there was uncertainty over the restrictiveness of rates. None of these conditions exist today,” she outlined.

Dr Auld said recent data pointed to softer momentum across the economy while acknowledging that at the same time, uncertainty remains a key feature of the outlook.

“Both Q1 GDP data and the NAB business survey suggest momentum in the economy has slowed, meaning that growth has likely peaked for the cycle. That said, we are cognisant there is still considerable uncertainty around the outlook, both with respect to activity and inflation.”

Dr Auld said inflation risks and labour market outcomes would be important to watch.

“On the prices side, we are still forecasting above target core inflation through to mid-2027. Margins will compress and weaker labour market outcomes are a risk.”

She said tighter financial conditions are expected to weigh on housing and activity.

“Tighter financial conditions will be reflected in a slowing in house price growth and housing credit growth. In summary, we have greater conviction that the next move in rates is down, but less conviction on the timing.”

Mortgage relief? NAB forecasts RBA rate cut, not hike, after softer economic conditions

A local downsizer has splashed $6.5 million on a penthouse in Perifa's Alex &amp; Willow development in Crows Nest. 
&nbsp; 
The purchaser sold their long-held family home in the area before embarking on a six-month search for the right apartment. After inspecting a range of options across the Lower North Shore, the buyer returned to <a href="https://www.apartments.com.au/new-apartments/alex-willow-crows-nest-82-90-alexander-street-crows-nest-nsw-2065">Alex &amp; Willow</a>. 
&nbsp; 
The buyer profile reflects the project’s broader purchaser mix. <a>Alex &amp; Willow</a> has attracted predominantly local downsizers looking to transition from larger homes without compromising on space or quality, alongside a smaller cohort of upsizers and investors drawn to the project’s location and design credentials. 
&nbsp; 
The milestone sale comes as the project, developed by&nbsp;<a href="https://www.apartments.com.au/developers/perifa">Perifa</a>&nbsp;and delivered by <a href="https://www.apartments.com.au/builders/versatile-made-construction">Versatile Construction</a>, both part of Versatile Group, reaches 60 per cent sold.

[smartcode_project:default project_id=6680 project_image_fid=371325] 
&nbsp; 
Eddie Mansour, Managing Partner of <a href="https://www.apartments.com.au/project-marketer/ray-white-projects">Ray White Projects</a>, said the result demonstrates not only a headline price but also depth of demand. 
&nbsp; 
“This is an exceptional outcome and a clear reflection of sustained buyer demand for premium, well-located downsizer product,” Mansour said.

“We’re seeing a consistent pattern of local homeowners selling family residences and reinvesting into high-quality apartments that allow them to remain within their community. Alex &amp; Willow has resonated strongly with this group because it offers genuine scale, thoughtful design and immediate proximity to the village.” 
&nbsp; 
The sale reflects a broader and consistent trend of local downsizers actively seeking high-quality, low-maintenance residences close to established village centres. Agents report that demand for this product type has remained resilient, particularly where developments offer a rare combination of scale, design quality and walkable amenity. 
&nbsp;&nbsp; 
Fabrizio Perilli, Managing Director of Perifa and Versatile Group, said the sale marks a defining moment for the project. 
&nbsp; 
“The penthouse sale is a strong endorsement of the quality we have delivered, alongside our partners, and the clear demand from local downsizers for premium, boutique residences in this location,” Perilli said.&nbsp; 
&nbsp; 
“Most importantly, we’re proud to see the Alex &amp; Willow community beginning to take shape. As we move closer to completion, we’re looking forward to welcoming residents and seeing the project come to life.”&nbsp;

[smartcode_project:default project_id=6680 project_image_fid=338516] 
&nbsp; 
Designed by <a href="https://www.apartments.com.au/architects/nettletontribe">Nettleton Tribe</a> with interiors by <a href="https://www.apartments.com.au/interior-designers/richards-stanisich">Richards Stanisich</a>, Alex &amp; Willow is a boutique collection of generously sized two- and three-bedroom residences in the heart of Crows Nest village.&nbsp;

Completion is slated for early 2027.

[smartcode_project_cta:default project_id=6680]

Alex & Willow, Crows Nest penthouse sells off the plan for $6.5 million

Fresh from launching the first stage of its Wollongong precinct, <a href="https://www.apartments.com.au/new-apartments/keira-place-wollongong-120-122-smith-street-wollongong-nsw-2500">Keira Place</a>, builder-developer Urban Property Group has unveiled plans for the next phase of the masterplanned community.

Now on public exhibition through the NSW Government's Housing Delivery Authority pathway is a State Significant Development Application for a further 657 homes on the prominent gateway site opposite Beaton Park.

The proposal comprises three buildings, including two build-to-sell towers rising 25 and 30 storeys, delivering 391 apartments, alongside a 12-storey co-living building with 266 residences, making it one of the largest co-living proposals currently planned in regional New South Wales.

Of the apartments proposed in the build-to-sell towers, the majority, 310, are two-bedroom dwellings. The balance comprises 44 one-bedroom apartments and 37 three-bedroom residences. Apartment sizes range from around 50 sqm for one-bedroom homes to approximately 90 sqm for three-bedroom apartments.

<img alt="Smith St" data-entity-type="file" data-entity-uuid="19347059-1612-41a0-9c74-b86a657237f8" src="https://s3.ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/inline-images/Screenshot%202026-06-10%20at%2010.02.18%E2%80%AFAM.png?VersionId=sWXnaCcA.cIC6N8YT1dg5pJ2e1V3Z6z7" />

The submission says the proposal has evolved significantly from its original Housing Delivery Authority application following extensive consultation with the State Design Review Panel and Wollongong City Council.

The final scheme has been designed to align with the emerging vision for the Flinders Street Precinct, an area identified by Council as a future high-density mixed-use neighbourhood capable of accommodating substantial housing growth close to transport, employment and community infrastructure.

According to the design report prepared by COX Architecture, the development aims to "deliver a built outcome consistent with the future character of the Wollongong CBD while responding to the site's unique constraints and opportunities."

"Our vision for the next phase of the site evolution in Wollongong is grounded in three design pillars that guide the design response: place, natural environment and celebration," COX said.

"Inspired by its surroundings and grounded in the stories of place on Wodi Wodi Country, the design proposal acknowledges the established character of its setting while creating a unique and timeless identity that sits harmoniously within it.

"The design proposal responds to its specific site conditions, acknowledging the vegetation, climate, wind conditions and solar access of the site."

The architecture responds directly to the site's position between Wollongong's urban core and its natural landscape setting.

COX identified views towards Mount Keira and the Illawarra Escarpment as defining features of the site, while the upper levels of the towers will also capture expansive views across the city and out to the Pacific Ocean.

The design team has positioned the tallest buildings closer to the rail corridor, where overshadowing impacts can be better managed while establishing a landmark built form on the northern approach into the city.

<img alt="Smith St" data-entity-type="file" data-entity-uuid="79580d5b-500c-4ebf-9629-797146a4a694" src="https://s3.ap-southeast-2.amazonaws.com/www.urban.com.au/s3fs-public/inline-images/Screenshot%202026-06-10%20at%209.51.59%E2%80%AFAM.png?VersionId=WbTB1EKSG.KDfsfz0F3wp1QVa2oCMGR5" />

Urban Property Group secured the 11,000 sqm Smith Street site in 2022 and has since progressed plans for the broader Keira Place precinct.

Construction recently commenced on the first stage of Keira Place, which will deliver 150 apartments across two residential buildings, including 27 affordable housing apartments and 18 specialist disability accommodation dwellings, alongside activated ground-floor retail and commercial space.

Urban Co-CEO Patrick Elias said the commencement of construction marked a significant milestone for Wollongong and reflected the developer's long-term commitment to regional cities.

"Today's groundbreaking is about turning approvals into homes and moving quickly to deliver much-needed housing in Wollongong's city centre," Elias said.

"Keira Place will provide a diverse mix of homes close to jobs, transport and services, while setting a high benchmark for quality, durability and consumer protection."

Read more:&nbsp;<a href="https://www.apartments.com.au/news/nsw/groundbreaking-marks-start-of-construction-at-keira-place-in-wollongong-cbd">Groundbreaking marks start of construction at Keira Place in Wollongong CBD</a>

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&nbsp;

Christopher Joye

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